Conversations With a Developer

Finding Out Who They Are

When I purchased one of my properties on Newhall St in Santa Clara, we saw that the house across the street from us was also bought on the market. Over time, we saw them tear down the entire home and start a new construction project. I was curious to see who they were, so I snooped on the internet to see who purchased it. I wanted to know their business strategy and all the details about their deal. I saw that it was purchased under an entity’s name. With a  quick Google search, I found their home page and saw all of their contact information.

This was back in December. For months, I was too shy to reach out to them. What if they rejected me? What if they didn’t want to share their knowledge? I finally bit the bullet and reached out to them earlier this week. I framed the email to show that I could produce value to them. It’s true, I can send them deals that don’t work for me, but could work for them.

I was surprised to see them reach out to me and agree to meet for a quick cup of coffee.

Here is what I learned from the developer…

Partnership

The company is a partnership of two main leads with six total members. One partner comes from a finance background and is a pro at raising capital. The other has been investing in homes for the past ten years.

Another key member of the group is a general contractor/project manager. He’s in charge of making sure the different projects run smoothly on time and on budget.

The last three are in the real estate side. One is a broker who lists all of the properties during the disposition phase. The other two are junior agents who spend their time looking for good deals.

Financing

The most interesting part of their company is how they finance properties. Unlike most flippers, they don’t use ANY leverage in their deals!

They have a fund where accredited investors pool their money into. The company charges a 1.5% asset management fee. For a $10 million fund, that’s an extra $150 k just for setting it up! They purchase properties with true CASH offers with this money. They also fund the entire rehab with it.

Now they don’t have to worry about projects getting delayed and spending hundreds of thousands of dollars on interest and origination fees.  They can also sit on a property for as long as they need to since their holding costs are so low.

Their investors are happy with this structure since it’s hard for them to lose money.

This is how they pay their investors out. Investors get a 10% preferred return. This means that before any profits are paid to the developers, the investors get paid until they get 10% of their investment as profit. i.e. if I invested $100 k into the firm, I’ll get my original $100 k plus an additional $10 k back before the developer sees any returns. After the preferred return is paid, the rest of the profits are split 70/30. 70% goes to the investors and 30% goes to the developers. This is an above average return for a syndication. Most syndications pay out an 8% preferred return and then do 70/30 split.

Because of the preferred return, they’re looking for projects with a greater potential for profit. If the profit is only marginal, then it’s not worth it since the developer won’t see any of the returns for doing the work.

Building

The developers have an in-house crew. By having many projects, they’re able to hire a few people full-time. They’re also able to keep costs down since everyone is on a salary. New construction builds can go up to $350/sqft. They’re able to do it for $200/sqft.

It takes about 9 months to a year to build a new home. 5-7 of those months are due to the long planning process. They have connections with great architects and structural engineers, which helps speed it up.

Buying Criteria

By having everything set up this way, they’re able to make more aggressive offers. Their mentality is that they are creating value, not relying on ‘sweetheart deals’. It’s true, it’s getting harder and harder to buy properties significantly below market value. There are only so many hoarders out there. People in the Bay Area are not that motivated to sell. They know that they can just put it on the market and it will take care of itself.

Because of their waterfall curve (the way they break down the profit), they need to get a decent projected return on their deal. They want a 30% year over year ROI. So if a project’s total cost is $2 million, they expect it to sell for over $2.6 million. If their build cost is ~$200/sqft and they create a 3000 sqft home, then their build cost is around $600,000. This means that they need to acquire the land for $1.4 million.

They focus on buying properties that are dilapidated and small, but on a big lot. They can then raze the building and put a new one on there to maximize the value.

Horizontal Development

In the future, they create a new branch that will move towards the entitlement process to generate more profit. They can identify a building or lot and think of ways to maximize its value. They’ll go through the entitlement process and sell the lot with the plans to a builder. They can even sell their plans to their own building branch!

Conclusion

There are lots of ways to make money in real estate, and lots of ways to lose it. You need to find ways to maximize the upside while minimizing the downside. Learn to bring in partners to expand the pie and make everyone win. Learn to make money for others and you’ll be wealthy as well. If you want to learn more tips and secrets to making seven figures a year in real estate investing, check out my podcast at https://everythingrei.com/podcast/